The U. S. Dollar – Quo Vadis?

Dr. Robert T. LeClair

John Cabot University

Rome, Italy

1-1-1999Austria (€)Belgium (€)

Denmark (ERM II)Finland (€)France (€)

Germany (€)Great Britain (£)

Ireland (€)Italy (€)

Luxembourg (€)Netherlands (€)

Portugal (€)Spain (€)

Sweden (SKr)

1-1-1999 1-1-2001Austria (€) Greece (€)Belgium (€)

Denmark (ERM II)Finland (€)France (€)

Germany (€)Great Britain (£)

Ireland (€)Italy (€)

Luxembourg (€)Netherlands (€)

Portugal (€)Spain (€)

Sweden (SKr)

1-1-1999 1-1-2001 5-1-2004Austria (€) Greece (€) Cyprus (€) [1/08]Belgium (€) Czech Rep.

Denmark (ERM II) Estonia (ERM II)Finland (€) HungaryFrance (€) Latvia

Germany (€) Lithuania (ERM II)Great Britain (£) Malta (€) [1/08]

Ireland (€) PolandItaly (€) Slovakia (€) [1/09]

Luxembourg (€) Slovenia (€) [1/07]Netherlands (€)

Portugal (€)Spain (€)

Sweden (SKr)

1-1-1999 1-1-2001 5-1-2004Austria (€) Greece (€) Cyprus (€) [1/08]Belgium (€) Czech Rep.

Denmark (ERM II) Estonia (ERM II)Finland (€) HungaryFrance (€) Latvia

Germany (€) Lithuania (ERM II)Great Britain (£) Malta (€) [1/08]

Ireland (€) PolandItaly (€) Slovakia (€) [1/09]

Luxembourg (€) Slovenia (€) [1/07]Netherlands (€)

Portugal (€) 1/1/2007Spain (€) Bulgaria

Sweden (SKr) Romania

Headlines

• “Dollar faltering after seven years as leading currency” -USA Today

May 30, 2002

• “Dollar’s Drop Shows Loss of Faith in U. S. Economy”

-Wall Street Journal (Europe)June 3, 2002

Headlines

• “Dollar hits 14-month low versus Euro” -Financial Times

May 28, 2002

• “There are signs that the U. S. primacy as an investment location is now under threat” -Financial Times

May 31, 2002

History of European Monetary Union

• Maastricht Treaty (2 Feb. 1992)• Single Central Bank: (1 June 1998)

– European Central Bank (ECB)– Frankfurt, Germany– www.ecb.int/home/

• Single European currency (“Euro”)

History of European Monetary Union

• Qualification standards:– inflation– interest rates– fiscal deficit– national debt

EMU Convergence Criteria

• Inflation: no more than 1.5% above avg. of three members with lowest rate

• L-T interest rate: no more than 2% above avg. of three members with lowest rate

• Fiscal deficit: no more than 3% of GDP

• Govt. debt: no more than 60% of GDP

History of the Euro (€)

• Officially introduced: 1 Jan 1999

• Currency and coins introduced: 1 Jan 2002

• “Legacy” currencies (Franc, Mark, Lira, etc.) no longer legal tender after 28 Feb 2002

Euro vs. USA[Source: Wall Street Journal, 9/28/98]

Euro-11 USA

Population 290 million 267 million

GDP $8.2 trillion $8.6 trillion

% World GDP 19% 20%

% World Trade 19% 17%

Stock Mkt Cap $3.6 trillion $9.5 trillion

$ Value of the Euro (€)

• Quick Quiz:

• What would you have paid to buy one Euro (€) on January 1, 1999?– A. more than $1.00

– B. exactly $1.00

– C. less than $1.00

$ Value of the Euro (€)

• 1 January 1999: $1.1719

• 26 October 2000: $0.8228 (low)

• 1 January 2002: $0.8920

• 22 April 2008: $1.6018 (high trade)

• 24 April 2008: $1.5952 (high close)

• 1 October 2009: $1.455

$ Value of the Euro (€)

Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

$ Value of the Euro (€)

Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

$ Value of the Euro (€)

Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

$ Value of the Euro (€)

Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 - 12.73%

$ Value of the Euro (€)

Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 - 12.73%

1 Jan 2007 $1.3203 +11.49%

$ Value of the Euro (€)

Date $ Value % Change1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 - 12.73%

1 Jan 2007 $1.3203 +11.49%

1 Jan 2008 $1.4704 +11.37%

1 Jan 2009 $1.4043 -4.49%

Euro (€) versus the U. S. $[Interbank Rate – 1/1/99 to 10/1/09]

Who Needs Dollars?

• People who want to …– buy U. S. goods and services

– invest in U. S. assets

– travel to the U. S.

• Anyone who wants to buy oil!

Why the weak Euro (€)?Why the strong U. S. Dollar ($)?

1. Stronger U. S. economic growth

2. Shrinking U. S. Government deficit

Why the weak Euro (€)?Why the strong U. S. Dollar ($)?

1. Stronger U. S. economic growth

2. Shrinking U. S. Government deficit

3. Strong U. S. stock market performance; compound annual returns for ten years ended -

2001: +13.00% 2005: + 9.07%

2002: + 9.34% 2006: + 8.35%

2003: +11.07% 2007: + 5.91%

2004: +12.07% 2008: - 1.38%

What’s Changed to Weaken the $?

• Slower U. S. growth

U. S. A. GDP Growth (%), 1993 - 2009

What’s Changed to Weaken the $?

• Slower U. S. growth

• Large U. S. government deficits

U. S. Budget Deficit/Surplus[1990-2009, $ Billions]

What’s Changed to Weaken the $?

• Slower U. S. Growth

• Large U. S. Government deficits

• Weaker U. S. market returns (S&P 500):

2000: - 9.1% 2005: + 4.9%

2001: - 11.9% 2006: +15.8%

2002: - 22.1% 2007: + 5.5%

2003: +28.7% 2008: -37.0%

2004: +10.9% 2009: +18.0%

Compound Annual Returns, S & P 500[Ten-Year periods Ending 2001-08]

-202468101214

Percent(%)

2001

2002

2003

2004

2005

2006

2007

2008

Year

P/E Ratio, S & P 500 Index (TTM)[Monthly, 1/1/02 – 10/1/09]

Political Effect?

• U. S. Treasury Secretaries:

• Robert E. Rubin(1995-1999) – “strong dollar”

• Lawrence H. Summers(1999-01) – “strong dollar”

• Paul H. O’Neill(2001-02) – “market decides the value of the dollar”

• John W. Snow(2003-06) – “A strong dollar is in the national interest.”

Political Effect?[U. S. Treasury Secretaries]

• Henry Paulson (2006 -2009) – “As I think you know, I believe very strongly that a strong dollar is in our nation’s interest, and I’m a big believer in currencies being set in a competitive, open marketplace.”

Achilles Heel?[Financial Times, May 31, 2002]

• “The Achilles heel of the US dollar has been the bulging current account deficit, which is expected to reach $465bn (€516bn) this year.”

U. S. Current Account Deficit[1998-2009, Quarterly, ($ Billions)]

Achilles Heel?[Financial Times, May 31, 2002]

• This means the US needs to attract $1.3bn in overseas funds every day to prevent the dollar from falling.”

U. S. Avg. Monthly Net Capital Inflow ($Billions, 2001-2002)

Financial Times , Friday, May 31, 2002

44

14.6

2001 2002

Year

Foreign Trade (-) and Capital Flows (+)[2005-2009; $ Billions]

Foreign Trade (-) and Capital Flows (+)[2005-2009; $ Billions]

Foreign Holdings of U. S. Treasury Securities

Source: U. S. Treasury International Capital (TIC) Reports, monthly

[www.treas.gov/tic/mfh.txt]

Total Foreign Holdings of U. S. Treasury Securities, $Bils., 2005-09

Chinese Holdings of U. S. Treasury Securities, $Bils., 2005-09

Japanese Holdings of U. S. Treasury Securities, $Bils. 2005-09

“Oil Exporters” Holdings of U. S. Treasury Securities, $Bils., 2005-09

Major Foreign Holders of U. S. Treasury Securities, $Bils., - July 2009

Concerns About the US Economy?

1. Corporate governance and accounting standards (Enron; WorldCom; Xerox)

2. Productivity gains have not translated into higher corporate profitability

3. Surge in government spending …could depress economic growth

Impact of a Weaker U. S. Dollar[Disadvantages]

1. Foreign goods more expensive2. Foreign investment more

expensive3. Foreign travel more expensive4. U. S. interest rates – higher; less

foreign capital

Impact of a Weaker U. S. Dollar[Advantages]

1. American products are more competitive abroad; increased exports; lower U. S. trade deficit

2. U. S. A. manufacturing sector more competitive

3. Increased return on U. S. overseas investments

Return on Overseas Investments

$ Value of the Euro (€)

Euros

Earned

Dollar

Equivalent

$0.95

($1/ €1.053)€ 1,000,000 $950,000

Return on Overseas Investments

$ Value of the Euro (€)

Euros

Earned

Dollar

Equivalent

$0.95

($1/ €1.053)€ 1,000,000 $950,000

$1.00

($1 / €1.000)€ 1,000,000 $1,000,000

Return on Overseas Investments

$ Value of the Euro (€)

Euros

Earned

Dollar

Equivalent

$0.95

($1/ €1.053)€ 1,000,000 $950,000

$1.00

($1 / €1.000)€ 1,000,000 $1,000,000

$1.55

($1 / €0.645)€ 1,000,000 $1,550,000

Where Do We Go From Here?

• “Dollar slips to all-time low ($1.3667) vs. Euro”

– Associated Press– December 31, 2004

• “Bears are betting on a decline in the dollar.”

– Barron’s– August 21, 2006

Where Do We Go From Here?

• “OFF THE CHARTS; Dollar Sinks the Lowest Since It Started to Float”

– The New York Times

– September 22, 2007

• “Fear of European Slump As Currency Sets Record”

– The New York Times

– September 22, 2007

Where Do We Go From Here?

• “As Dollars Pile Up, Uneasy Traders Lower the Currency’s Value”

– The New York Times– May 23, 2009